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It's a gas! The Nobel Memorial Prize in Economics

This week, contracts won a Nobel prize. Or rather, economists Oliver Hart and Bengt Holmströmwere awarded the Nobel prize in economics for their work on contracts. Their studies have enhanced our understanding of incentives by examining how contracts affect relationships between employers, employees, societies and governments. The application of incentives to IP is broad - the innovation/social contract approach to IP, patents as performance indicators in employment contracts, and, the bread-and-butter of IP, licensing contracts.

Eyes on the Prize
First of all, a bit of background. If you are an economist who supports the selection, i.e. that the winning economist's work supports your own work, then you must praise the Nobel committee's choice and the prestige of the prize. If you are not, then you must highlight that the economics prize is not a true Nobel prize, as it is comes from the Swedish National Bank, and therefore is not particularly impressive. Either way, one must be careful not to be too enthusiastic about a fellow economist's success, lest it be taken for indication of an emotional imbalance.

Second of all, some tips if you, dear reader, are interested in winning said prize. First, start early and live long so that your genius has time to be recognised. Second, be male. Only one woman, Elinor Ostrom, has received the prize. Third, make sure you are somehow Western, and ideally American. Fourth, become at expert at posing for photos in front of books. Finally, surprisingly, remember you don't actually have to be an economist to win; John Nash, who had the gall to be a mathematician, won in 1994. Things really are going to pot.

Contract theories
Hart and Holmström have won the prize because their names both start with H they developed complementary contract theories. Holmström began by studying trade-offs in contracts. The classic illustration is insurance, which combines both information asymmetry, where parties in a contract do not have the same information, and moral hazard, where a party may engage in riskier behaviour because the risk is shared. For example, a health insurer has less information about the insured's lifestyle than the insured. [Merpel's insurer doesn't know how much catnip she consumes.] Once insured, the insured shares potential costs with the insurer, and will engage in riskier behaviour. [Merpel has taken up parkour, because she won't have to pay for the hospital bills.]

Hart built further on this theory by examining the incompleteness of contracts. No contract can possibly foresee every outcome and consequence of incentives. He argued that property rights help mitigate this, as they place the burden of decision making on those with the property - and hence those with a stake in the unforeseen outcomes. Hart's recent work on prisons illustrates this; summarised by The Economist: "In publicly owned prisons, managers might underinvest in quality-improving measures, but private owners face too strong an incentive to cut costs, leading to conditions for prisoners that are worse than those in public prisons." These incentives apply to most government services. A privatised patent-granting body would have different incentives than a public body (think of those renewal fee$!)

Contracts and IP
Readers of Katonomics will be familiar with economists' focus on the incentives-to-innovate theory of IP. This is often known as the Social Contract (covered previously here), in which IP is a contract between innovators and society; the monopoly protection of IP provides a long-term incentive to innovate. Society cannot foresee (information asymmetry) the value of each potential innovation, so all innovators are granted the same level of protection. Assigning the property right to the innovator incentivises innovation as the innovator has a stake in the outcome and the IP system as a whole.

Trophies, by R. Oxley, CC

A goal of researcher employment contracts is to align firms' innovation needs with employee incentives. Patents are sometimes used as a metric of performance. There is a large body of economic analysis on the use of patents as a measure of innovation; the general conclusion of which is that patents measure patents, not innovation. More specifically, Harhoff and Hoisl (2007) examine German policies via a large survey, and find that, unsurprisingly, more valuable patents are associated with higher levels of employee compensation. Baker (1992) models scientists' salaries as entirely dependent on the number of patents they produce (a problematic assumption.) In his model, scientists are unduly incentivised to work on "easy" patents and therefore the employer reduces the per-patent payment to avoid overpaying. Japan has recently changed its approach to patents, making it easier for employers to own patents generated by employees.

Finally, licensing contracts enjoy a never-ending analysis of incentives and clauses. The primary job of lawyers negotiating and drafting such contracts is to align the incentives in the contract with the needs of the client. While researching the biotech sector in 2007, I came across an interesting case. My interviewee had exclusively licensed a product on a royalty basis. The licensee instead marketed a competing product, leaving the licensor without royalties. The contract had been used to eliminate competition from the market, and failed to align the parties' incentives. Another anecdote is the use by wealthy Multi-national Companies (MNC) of reversion clauses when partnering with companies in developing countries. The MNC engages in joint research and market expansion, then deliberately causes the project to fail in order to trigger the reversion clause. Both background and foreground IP, as per the contract, revert to the MNC. It's a cheap way to expand internationally.

I invite readers to tell their stories of the odd quirks of licensing contracts in the comments. In the meantime, I'm off to work with Merpel on contract incentives of catnip producers. Fingers crossed for a Nobel!

It's a gas! The Nobel Memorial Prize in Economics
Reviewed by Nicola Searle
on
Saturday, October 15, 2016
Rating: 5

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16 comments:

Alfred Novel had a great understanding of the important things for the advancement of mankind when he created the categories for his prizes. If economics was either scientific or cultural, I'm sure Alfred would not have excluded it from his list. After all, moneylending has been around almost as long as the oldest profession, and there is no prize for that either. Good company.

Your comment on eliminating the competition is a very good illustration of things to be aware of. I always advise my smaller/naive/university clients of making sure they have a term in the licence that allows them the take back the technology and develop/market it if the other side decides to do nothing with the project.

University tech transfer often don't have the sophistication/expertise to be able to see all the ways they can be taken advantage of, and they are sometimes too desperate to find commercial partners.

In biotech patent filings have to be seen as a metric of performance, especially when you don't have any products yet which you are selling. However due diligence is often not able to distinguish between good and bad filings. As they become increasingly financialised I fear patents will become as complex and as risky as derivatives, with the potential for making lots of money, but also be a source of instability in the economic system.

I would refer to the concept of 'gaming the system'. Any set of rules is open to being cheated/milked. So performance targets for employees will be 'gamed' within 6 months as people figure out how to artificially inflate whatever parameter is being measured. Contracts/IP and any other rule/system is susceptible to gaming. Hart and Holmstrom's work is really a recognition of gaming happening in all contracts.

Known in physics as the observer effect, for which no Nobel prize has been given. Apparently mistaken for the uncertainty principle, which was the creation of a certain physicist called Heisenberg, for which a Nobel prize was justifiably awarded.

A similar phenomenom may occur in economics, where it isn't possible to know which way the economy is heading (e.g. 'further down the pan') when the current position of the economy is known to be 'down the pan'?

I hear that girls do better than boys in school these days. Is this evidence that girls are better than boys or that the education system is biased in their favour? The real evidence, as opposed to mere statistics, demonstrates that it is the latter, but these results are praised in the media without the slightest sense of hypocrisy.

Many in-house legal/patent departments are becoming female-dominant, which is also odd when you consider the statistics. Is this a case of the new female senior management having a discriminatory recruitment policy? Could they be meeting their new recruits at the 'Women in IP' get togethers, perhaps?

For what it is worth, I don't believe there is such a thing as positive discrimination and I am a firm believer in merit over bias/favouritism at all levels. Unfortunately, like attracts like, and ignorance is bliss.

If 25% of economists, today, are female, I would expect that to translate into 25% of prize winners to be female in 20 years. That is how long Nobel prize winners have to wait.

Anonymous of Tuesday, 18 October 2016 at 23:14:00 BST, we are all part of the same society, men and women, and we need to make society work in the best way for both genders. It does not have to be cut-throat competitive environment. Plenty of work places have a laddish,sexist environment which disadvantages women. I am male, and I can tell you many of my male friends, some in senior positions, are sexist. Our society is very much a case of work in progress when it comes to equality for the genders. Highlighting the odd case of positive discrimination does not really appreciate the bigger picture of what many women experience every day in the workplace or even walking down the street. We are meant to be in Fourth Wave Feminism but I know most of my male friends have been left behind when it comes to such enlightened thinking.

Women make up a larger percentage of economic students and early-career groups, compared to a smaller percentage of more advanced career groups. And this is not a time issue - in the 1970s, 7% of undergraduates were female, this had increased to around 25% by the time I did my undergraduate in the 1990s. A current estimate puts 35% of PhD students as female.

Contrast those numbers with only 1 female of 77 Nobel prize in Economics winners and only 12.8% of US tenured professors are women. And two very worrying stats - the percentage of undergraduate are female is going down and salaries for women relative to men are also decreasing!

“Female full professors in economics went from earning 95% of what male full professors earned in 1995 to less than 75% of what male full professors earned in 2010, a large and statistically significant difference.”

Statistics in the private sector are a bit trickier, as defining "economist" as a job isn't straightforward in that sector. I've not seen stats on government economists.

"in the 1970s, 7% of undergraduates were female" - This would explain why 'sham-nobel' prizewinners are male and only 12.8% of Professors are female. So, of course it is a time issue. Take a look at the ages of the latest chemistry Nobel Prize winners who where undergraduates in the 60's, never mind the 70's.

It may also explain the salary difference, but you have to analyse all factors, including experience and results (e.g. publications, funding). Why almost parity in 1995, but lower in 2010?

In the legal profession, I negotiated a pay rise for myself based on another job offer. A female colleague was then given an equal pay rise to match mine. She was less qualified and less experienced. Had she negotiated a pay rise for herself, there would have been no automatic matching of my salary.

I wouldn't take the Forbes survey too seriously when their link refers to "science-of-economics". It is NOT a science.

Regarding discrimination: Take a look around your offices and work out how many of your colleagues (male and female) are from non-upper-middle class backgrounds. The fight for equal pay appears to be equal within a privileged section of society.

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